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Tuesday, January 26, 2010

Gold is not the Answer in Case of Major Instability

Gold bugs often say that it’s important to own gold because it is something real that will retain its value even if runaway inflation devalues cash. I don’t spend much time planning for the breakdown of society, but recent events in Haiti can cause us to think about what we should own that will retain some value when everything else is becoming worthless.

In the face of extreme societal breakdown, nothing can really retain much value, but for lesser calamities, some things are better than others. It’s certainly true that poor fiscal management by governments combined with demographic changes, depletion of natural resources, and natural disasters could cause major instability leading to very high inflation.

However, I don’t see gold as the answer. It has little inherent value. In the face of food shortages, why would anyone trade some food for gold? It’s true that money only has value because we all agree it has value. But the same is true of gold. If things get bad enough, we could just as easily lose confidence in gold as we could lose confidence in money.

So, what could hold its value when everything else is becoming worthless? One possibility is real estate. As long as society continues to respect land titles, real estate should have some value.

The best answer I can think of is a stock index. Owning a small slice of thousands of companies across North America (or the whole world) is a good way to protect against calamity. I would rather own a slice of all business than a few pounds of gold.

I see little point in planning for the worst possible disasters, because almost all things will become worthless other than air, water, food, and shelter, and it would be difficult to control any of these things in great abundance. For lesser calamities, I’d rather own stock index units than gold.

Yep, I agreewithyou. Incidentally, was delighted this week to find out that I've now broken even: the gains on my "new money" invested since the crash have now canceled the losses on my "old money" that was already in the market at the time. (This, despite the fact that there is much more "old money".)

The main thing that worries me is the fact that most of my net worth exists only as numbers in a computer. I'm not sure what to do about that...

Oh, and I enjoyed the Book of Eli, perhaps because my expectations were low. I just wish someone had told the director when the movie was over; it seemed to keep going on for another 15 minutes for no apparent reason.

You could stockpile water, or gasoline, that will have value in major disasters. Guns and bullets might be useful too, if you are sure society is going to break down (then again a Tank might be useful in that situation, but the Wal-Mart was out of thoses last I checked).

You could stockpile pennies too, they would have great value in a calamity, you fill your sock with it and it makes a cheap weapon!

I agree with you. I read in one of the books on the Second World War that goods most prized in war-ravaged economies were cigarettes and chocolates. If things get even worse, it's questionable if a cache of cigarettes or chocolates or whatever will be of any help because it will simply get raided.

In any REAL, long-term calamity, food and water and possibly weapons will win over everything. The rich man will suddenly find his paper stocks are worthless if he's starving or dying of dehydration.Short-term, like Haiti, not sure. I guess money in the bank to help you rebuild or get the hell out is a good thing?

In a true Armageddon style scenario no asset is going to do you any good except maybe a cache of weapons.

In all other situations Gold will have value because humans have irrationally assign value to it and have done for thousands of years and continue to do so. I don't see any sign of humans becoming more rational, do you?

A good chunk of gold or silver for that matter is an insurance policy for those not quite Armageddon moments. It should hold it's purchasing power over time as global governments do their best to inflate their debts away.

Personally I am long physical gold and silver and am up over 50% but I was lucky to buy the bulk of my investment during Nov 08 and freely admit it was a bit of a calculated gamble.

My portfolio is probably 60% in metals at the moment. I'm not much of a fan of over diversification. A concentrated portfolio watched like a hawk is a better approach I believe.

Anonymous: You're probably right that humans will continue to assign value to gold, but I'm definitely not satisfied with just holding on to my purchasing power. Stock indexes have the expectations of outperforming inflation with high probability over long periods. I'm not convinced that gold will outperform business even in the face of adversity.

Unless you are investing in dividend stocks holding metal is much the same as holding equities with the exception that when you hold physical metal there is no counter-party risk.

As companies raise their prices to combat inflation the price of gold will also increase.

It's really knowing when to be in metals/commodities and when to be in equities.

If you look at a chart of a broad index divided by the price of gold you can easily which asset is out performing and move into it.

I don't know if you can read a point and figure chart but at the moment it's unclear which asset class is winning but you can see that Gold has out performed stocks for the past 8 years (as far back as this chart goes).

Basically this shows the declining value of the S&P500 compared to an ounce of gold.

Anonymous: It's hard to tell, but it looks like that chart does not take into account dividends. This wouldn't be enough to level out the graph, but it would make the decline a little slower. I'm not big on market timing, but doesn't the decline of stocks relative to gold mean that now is a good time to sell some gold and rebalance back into stocks?

It might, however I would sacrifice some of my metals gains to be sure that stocks where outperforming before any re-balancing. It has a away to move before I see it as a confirmation that the great Gold bull market is over.

The trend is your friend, right!?

As a disclosure I am also long some stocks but my exposure is smaller than my metal holdings.